Emerging Market Dividend ETF Trouncing the Competition

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WisdomTree Emerging Markets Equity Income (NYSEArca: DEM)is much smaller than its two main rivals in the diversified emerging market ETF category but the fund’s dividend-weighted approach has helped it handily outperform the competition.

DEM has a five-year annualized return of 7.7% versus 2.2% for EEM and 1.9% for VWO, according to investment researcher Morningstar. DEM has also been less volatile than its larger rivals.

The outperforming WisdomTree fund tracks an in-house index designed by the ETF provider. The benchmark is a so-called fundamentally weighted index that targets emerging market stocks with high dividend yields. Also, companies are weighted based on annual cash dividends paid to shareholders. DEM tends to have a tilt to value stocks.

Meanwhile, EEM and VWO weight stocks based on their size, or market capitalization.

“For example, Taiwanese and Brazilian companies tend to be higher dividend payers due to tax rules and laws that support dividend payouts,” Oey said. “As a result, emerging-markets dividend funds, including DEM, tend to have substantial exposure to these countries.”

Potential investors should be aware that the ETF does not hedge against currency risks, so a depreciating U.S. dollar would potentially augment returns but a weakening emerging market currency can negatively affect the ETF.

DEM’s exposure to Russia increased from a low-single-digit percentage over the last few years to 13% since the last rebalance, which is a significant overweighting compared to the MSCI Emerging Markets Index of 6%.

“While Russia is currently trading at cheap valuations (the MSCI Russia Index is trading at about 5 times trailing 12-month earnings versus a five-year average of 7 times), investing in Russia is a very risky proposition – the country’s stock market has very heavy exposure to the energy sector, the ruble is extremely volatile, and corruption within Russia is rampant,” Oey cautioned.

DEM’s weighting toward China has increased to 16% from 4% over the last two years, with a heavy concentration in Chinese banks.

“They are still exposed to the potential of souring loan portfolios and may need to trim dividends to strengthen their balance sheets, which would negatively affect share prices,” Oey said. “The government also plans to liberalize interest rates in an effort to stimulate competition. Such moves could threaten these banks’ highly profitable oligopoly.”

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.